Match effects

•Match effects explain 16 percent of earnings variation.•They also explain much of the change in earnings when workers change employer.•Omitted match effects upwardly bias the estimated return to experience.•Omitted match effects downwardly bias the return to sorting into good firms.

We present direct evidence of the importance of matching in wage determination. It is based on an empirical specification that estimates the returns to person-, firm-, and match-specific determinants of match productivity. We call these person, firm, and match effects. The distinction between these components is important, because they have different implications for the persistence of individual earnings and the returns to employment mobility. We find that match effects, which have been ignored in previous work, are an important determinant of earnings dispersion. They explain 16 percent of variation in earnings, and much of the change in earnings when workers change employer. Specifications that omit match effects substantially over-estimate the returns to experience, attribute too much variation to personal heterogeneity, and underestimate the extent to which good workers sort into employment at good firms.